From three Chicago academics, a push for HFT quality management standards

First Published 8th August 2012

In the aftermath of the Knight trading disaster, three academics have asked the X9 standards body to consider their proposal for HFT quality management standards.

Ben van Vliet, Illinois Institute of Technology

"It's a way for the industry to say, 'We take ethics seriously, we take the quality of our systems seriously.' Because I think if the industry doesn't do that, they're going to be regulated into oblivion."

Three Chicago-based academics have proposed
creating standards for quality management in the high frequency
trading arena.

Work on the proposal had begun long before last week's trading
disaster at Knight Capital Group, but the authors decided to go
public with their ideas once news emerged of the software glitch
that cost the Wall Street firm $440 million.

Ben van Vliet, assistant professor at the Illinois Institute of
Technology (IIT), said the X9 financial industry standards body
was considering whether to set up a committee to oversee
development of the standards.

Van Vliet, along with Adjunct Professor Andrew Kumiega and
Assistant Professor Rick Cooper, both of whom are also at IIT,
and Jim Northey of FIX Protocol, have co-authored a paper called
"The rationale for HFT 9000: An ISO 9000-style Quality Management
System for High Frequency Trading".

"It's a way for the industry to say, 'We take
ethics seriously, we take the quality of our systems seriously.'
Because I think if the industry doesn't do that, they're going to
be regulated into oblivion," van Vliet told Automated
Trader.

He said he had presented the proposal to the markets regulatory
staff at the Chicago Mercantile Exchange and that it has been
circulated to the Commodity Futures Trading Commission and the
Securities and Exchange Commission.

The paper notes that the SEC and CFTC had lowered the bar for
proving market manipulation from intent to recklessness.

"So, in the case of failure of an HFT system, how can the
organisation prove it was ethical, that it was prudent in its HFT
research and development (R&D) and operation and control
(O&C)?" the authors wrote.

The answer, they said, was that they could do so by showing they
followed a recognisably prudent process that documented the firm
was justified in believing in the stability of its HFT system.

"By following ISO 9000-style standards, an HFT
firm can satisfy their organisational ethical obligations
to prove and document that its HFT strategies and technologies
will operate safely and profitably," the paper said. "There is
also a wide body of literature demonstrating that the use of
quality management systems increases the financial performance of
the firm."

Examples of specific requirements in HFT 9000
are: that the firm has installed and verified safety
controls such as "kill switches", verified acceptable algorithmic
behaviour under a variety of market stress conditions, and
employed proper software and system version release management.

The authors said the probability of failure can never be driven
to zero due to unexpected interactions between proprietary
systems, but quality management systems have been proven very
successful across a number of industries.

Asked whether Knight was a factor in the decision
to push forward with the proposal, van Vliet said: "Absolutely.
My phone started ringing off the hook."